Bad Folk Economics, 11/24
Be suspicious of the term "supply chain."
Despite two centuries and a half of economic analysis, supply-chain talk typically ignores the crucial role of prices on the open market. Prices are bid up here and bid down there, continuously adjusting quantity supplied and quantity demanded, reconciling scarce resources and nearly infinite human desires. (See Hayek, “The Use of Knowledge in Society,” American Economic Review, 1945.) Except when government cap prices like during the first year and a half of the pandemic, or when the mob descends in a witch-hunt of “speculators,” “profiteers,” and “price-gougers,” goods keep moving in response to price signals and disruptions don’t last.
If you think that complex production involving many steps, multiple countries, and many different people is a 21st-century phenomenon, I suggest that you consult I, Pencil, an essay by Leonard E. Read written in 1958.
The term “chain” is misleading in at least two ways. First, it suggests something that is designed. As if every retailer has the necessity and the ability to design its supply chain. It has neither.
Second, it suggests that complex, multi-stage production processes are fragile. If one link breaks, the whole chain must break. But in fact, a market economy is more like the Internet. When a Web server sends your computer a packet of information over the Internet, there are many possible routes it could take. If one route is broken or crowded, the packet takes a different route.
Instead of “supply chain,” we should say “roundabout production,” the term preferred by Austrian economists. For example, an automobile is the final product of millions of early steps. Some of these steps involve constructing factories and machinery. Not only to assemble the car, but also to assemble the metals and the computer chips that go into the car.
How does the economy know that chips need to go to car manufacturers, rather than somewhere else? Prices provide the guide. If consumer behavior raises the price of video game players relative to the price of cars, then the price system will direct manufacturers to supply more chips to gaming-device producers and fewer chips to automobile producers.
Unfortunately, there is a lot of bad folk economics out there, much of it coming from credentialed economists. Don’t think about “supply” as some fixed amount and “demand” as some other fixed amount. Instead try to grasp the notion that supply and demand intersect at a market-clearing price.
“Supply chain” is another piece of bad folk economics. Instead, think in terms of roundabout production, guided by the price system.
Wouldn't a "supply network" be a more accurate term? I've never understood what Austrians meant by "roundabout". But a network... well, that works exactly like the internet(work) example you gave. Independent nodes of production, who send their product along to other nodes. If they get a better signal (i.e. a higher price), they send change and send their product along to the higher priced node.
Beyond that, I always have the sense that too much emphasis is put on price. "Expectations" do a lot of heavy lifting in monetary economics. Probably too much, because there's not really a systematic understanding of what is meant by the term (similar to "inflation"). And yet, I'd think about expectations here as a good framework for how production nodes evaluate price signals.
If they didn't, how else do we explain why it took me 7 months to get the new couches I ordered? In a price-determinant world, this shouldn't happen. Why are producers leaving this kind of profit opportunity on the table? Our basic understanding is that they should raise prices or increase production, but neither seems to happen. I think this is based on their expectation that the price increase is short-term and that, for reasons unknown, they don't feel they can raise prices in the short-term, but I don't have a good sense of what those reasons are.
Supply chain is as good a term as any to describe interdependency in production of a good (“without a nail”, and all that). If you treat that as a literal description of how parts are sourced, of course it is going to be wanting, as one doesn’t just buy chips, screws, or financial instruments from a single source. It would seem more accurate to say that cars aren’t being built because chips are too expensive for what the car can sell for, but those chips had to be ordered 18 months ago — and there is no spot market in ASICs (as they are not fungible). Note the WSJ article on how chip fab houses for the automotive market used to allow last minute cancellations of fab orders. They don’t anymore, because they don’t have to, and that has decreased flexibility in the “chain”.
Analogies are just analogies, and simplifications simplify. Supply chain is a much less problematic term than Greedy Corporations.